Microsoft surprised no one with their unsolicited offer for Yahoo! in January 2008. What surprised some Wall Street observers was the premium Microsoft was willing to pay for Yahoo’s then share price. At that time the $31/share offer represented a 62% premium over Yahoo’s then share price of $19.18. What surprised the same observers was that, even that premium was not enough to sway Yahoo’s board in Microsoft’s favor. It will help to take a step back and put the offer in its historical context to understand the action of different players.
Yahoo’s History: Massive Fortune Swings
Long term Yahoo stock holders are no stranger to massive swings in its stock price. As one of the pioneers of the internet age, Yahoo’s legacy is enshrined in history.
One of the first darlings of the internet, it saw its stock price rise to stratospheric heights of $120+ at the peak of the .com bubble only to collapse to less than $5 in 2001. Since then the stock has recovered, reaching a high of $40+ in 2006, and traded as high as $34 last fall. The stock price fell significantly over the past six months as the Nasdaq sold off on the fear of an economic slowdown. Further, Google’s continued dominance and the failure of Yahoo’s internal initiative created further downside.
According to Alexa, the most popular web-sites in the world
are: yahoo.com, google.com, youtube.com, www.live.com (Windows Live), and msn.com. Based on Microsoft’s earnings reports, its online division is still not profitable even though they have the #4 and #5 web-sites in the world. Yahoo on the other hand, strongly lags Google when it comes to monetizing its traffic.
Yahoo’s Future: Is Growth Possible?
Yahoo detractors believe that the inability of Yahoo to monetize the eye-balls shows that it should not continue as an independent company and share-holders should accept Microsoft’s generous offer. The Yahoo supporters believe once Yahoo starts taking more drastic actions, including strategic partnerships with other firms, it will be quite easy to monetize the traffic and boost the share price. The online revenue model is highly levered and once the fixed costs are accounted for, a bulk of the revenue after the cost of sales falls to the bottom line. A 15% increase in average monetization per visitor, can almost double Yahoo’s earnings.
The View from the Valley
Silicon Valley and Microsoft have had a strained relationship over the past two decades. Valley entrepreneurs believe that Microsoft stifles innovation and growth by using the massive size of its installed base steam-rolling any competition.
The valley is littered with companies who were destroyed by the Microsoft Borg.
As one of the brightest, though fading, beacon of Silicon Valley, selling out to Microsoft is not any task for Yahoo to swallow. Microsoft was always the evil empire, and going over to the dark-side does not appeal to a lot of Yahoo workers, many of whom are reasonably wealthy after reaping their stock option rewards.
Jerry Yang seriously believes that selling out to Microsoft at the current price would be morally wrong.
As the CEO he has the right (or perhaps even the duty) to believe that Yahoo’s fortunes will become better; so a sell-out has to be at a price which justifies selling out.
Yahoo has friends in the valley. Both Google and Yahoo were spun out of Stanford and Yahoo had invested in Google.
Yahoo can and will tie up with Google, if that is what it takes to make things work.
The fact that a simple ad-serving trial got Microsoft to rush to the speed-dial to the Department of Justice, means that Microsoft realizes that too.
Microsoft’s offer came at a time when Yahoo’s stock had lost more than 40% of its value in a few months. It was timed and priced at a point to allay the fears of major institutional stock holders who had seen their asset values plummet.
However for Yahoo, it was adding insult to the injury.
The offer was still 10% less than what Yahoo was trading a few months before.
The View from Redmond
Financial: Isn’t 61% Enough
From a financial point of view, Microsoft is correct in believing that a 61% premium over Yahoo’s price before the offer is a rich enough premium. Many Wall Street pundits are banging the desks and saying that there is no point for Microsoft to compete against itself. Yahoo does not have any other suitor and the shareholders do not have any other option but to accept Microsoft’s offer.
However, what they miss is that Yahoo is a reluctant bride at best. It is also a proud company, secure about its legacy. Though the recent share-holders may not like it, the rank and file do not mind short term swings in stock price as long as they believe in the long term vision (lower short term prices mean cheaper stock options for the employees). And in spite of the missteps of the past few years, Yahoo continues to be the #1 site on the web. A few correct moves and they will be boogying in Sunnyvale.
Strategic: OMG!
With each passing day Redmond is realizing that Microsoft has the risk of becoming increasingly irrelevant. The last quarter’s earnings report showed that all its business units except for the one which makes the XBOX underperformed.
Microsoft lowered it’s near term guidance, though it guided up on its 2009 guidance. Microsoft blamed the macro-economic weakness. But other firms like Intel, IBM, Apple and Google are not showing any signs of the weakness Microsoft is blaming. There is something more happening and the bosses in Redmond k now
it.
The PC: The Mainframe of the 21st Century
Microsoft is at the same point where IBM and mainframes were a quarter century ago. The PC and Windows freed the average user from dealing with mainframes and the gurus who ran them. PCs were much less powerful than mainframes but their power was good enough.
We are at a similar point right now.
Users want to be able to do everything, anywhere, anytime. They do not want to be bound to their desktop or their laptop or even a particular brand of a smart phone. They rarely need the power of a quad-core CPU. They are no longer willing to pay a lot more for software than the hardware, especially when hardware multiplies. Like many users, I have at least three or four computers I use regularly. Purchasing a license of a Microsoft OS and Microsoft Office for each machine is too expensive and not worth it. I want to be able to use my applications from anywhere but I will not keep multiple copies of the same file or pay for multiple copies of the same software.
Operating Systems: Windows Everywhere No More
Another key fact which stood out is that Windows is no longer the impregnable castle it used to be. MacOS is growing its market share by leaps and bounds. The iPhone is likely to increase the adoption of the Mac, even in corporate environments. Since it is base on the UNIX framework, it can be easily extended for corporate applications. Linux is anyway the default OS for servers in many organizations.
Productivity Applications: Web-Apps Finally Arrive
The agreement by salesforce.com to start offering Google Apps to its clients was a water-shed event.
For the first time, there is an option for a small business to use CRM, and Office Productivity Apps, without having
to buy licenses up-front.
The end-user can access the applications from any web-connected device and is not bound to any particular hardware or OS.
Anecdotal evidence suggests that about 70% of all Microsoft Office users do not have any need for the advanced features offered by Office. Another 20% use some of the features, but rarely. It is the top 10%, the power users who need the full-fledged power of Office. Microsoft is at the increasing risk of seeing the huge installed base of Office applications erode.
Microhoo: Can Yahoo! do it For Microsoft?
Microsoft has not digested a company as big and diverse as Yahoo before. Further it is not clear that how Microhoo will integrate and work together.
Though challenges remain there are obvious synergies:
• Search: Apart from algorithms, search is a game of scale. The rapid increase in cap-
ex by Google is an indication of how much the leader will have to spend. A combined Microhoo can get that economy of scale and offer a viable alternative to Google.
• Profitable Online Businesses: Microsoft’s internet divisions continue to lose money though Yahoo! has been profitable for years. Whether it is web-apps or cloud computing, Yahoo can help Microsoft wean-off
its declining desktop franchise. Further, as a pioneer in the internet age, Yahoo! might (just might) have some of its original creativity and innovative spirit left in it.
• Foreign Relationships: Yahoo has made increasingly profitable investments in ventures like Alibaba.com in China. A less abrasive and more conciliatory Microsoft can use those as a launching pad into other emerging technologies and platforms.
There is no other company out there which can bring so much to Micro
soft. A properly executed merger can revive the fortunes of both also-rans.
Mr. Ballmer: Forget the Bean Counters
Microsoft is at an inflection point. It needs to take actions to preserve its legacy. These actions are going to be strategic in nature and the ROI will be measured over years, if not a decade. These actions will require a leap of faith.
Further, they will not get approval from bean counters who are not chartered to look beyond the current quarter or year.
However, it seems that Microsoft’s executives are spending too much time listening to the bean counters and Wall Street pundits who do not want Microsoft to bid against itself. These pundits forget that Yahoo, in its present form, is not for sale. A long drawn proxy battle will drain the value of Yahoo’s key franchise. Unlike Oracle, which bought companies for their installed base of customers, Microsoft also needs some of Yahoo’s DNA. That talent will flee in a hostile takeover.
A Higher Offer: How much will it Cost?
The $31 original offer corresponded to a deal worth $44.6B. A $35 offer, which many believe might do it, would correspond to around $50B. Microsoft’s current market cap is around $280B. Another $5-$6B is not a big deal in the big picture; it is just 2% of Microsoft’s market cap. However it can turn what can be a losing proposition into a win-win for everyone involved.
Microsoft’s bid in the first place was seen as a sign that the giant from Redmond is seeing cracks in its armor. No-deal now, will expose Microsoft to further questions about its future, especially after the weak results this quarter
Microsoft’s stock has traded within a range of $28-$32 since the offer was announced. How much difference will a 2% increase make? Microsoft has been underperforming Yahoo! over the past five years. Perhaps a merger with Yahoo is what Microsoft needs to get back on track.
